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A diverse portfolio of stocks demonstrating relatively lower volatility than the market rebalanced periodically, can deliver excess returns with lower downside volatility compared to the market (NIFTY 50) and the NIFTY100 Low Volatility 30 indices.

The specifics

  • Looks to outperform the NIFTY over holding periods of three years and longer
  • Is a 15-20-stock long-only portfolio, rebalanced quarterly in Feb / May / Aug / Nov each year
  • When appropriate it might hold other assets that meet the criteria (e.g. Gold ETF, REIT) or might be partly in cash
  • In rare cases, the strategy might make exceptions to make changes out of turn

Portfolio Performance

*Updated Weekly, refer to the date in the first row of the table below

The Capitalmind Low-Volatility Portfolio

Low Volatility is not a new concept in India. There is a NIFTY strategy index called the NIFTY 100 Low Volatility 30. In March 2021, ICICI Prudential launched an ETF based on this index. We already liked the idea of a passive instrument investing in low-volatility stocks and said as much in our NFO review.

The chart compares how ₹100 invested in the NIFTY100 Low Vol 30 index would do compared to the NIFTY.

The sizable difference in ending values over 16 years suggests there is something there for the investor looking to outperform the NIFTY. We set out to explore whether we take the core concept of lower volatility stocks and get a better risk-return profile.

Clearly, an attempt at creating our own low volatility portfolio had to not only outperform the NIFTY but also compare favorably with the Low Volatility index.

Our Hypothesis: A diverse portfolio of stocks demonstrating relatively lower volatility than the market, rebalanced periodically, can deliver excess returns with lower downside volatility compared to the market (NIFTY 50) and the NIFTY100 Low Volatility 30 indices.

Sticking to the core principle of building portfolios of stocks showing relatively lower volatility and rebalancing quarterly, we examined various rules that would help prove or disprove our hypothesis.

Table below shows a summary of the performance of the CM Low Vol Portfolio versus the NIFTY and the NIFTY100 Low Volatility 30.

Aggregated performance metrics condense long periods into easy-to-understand metrics. On the other hand, they lose out on the nuance of performance comparison over specific periods.

The chart below compares the 1 and 3-year rolling returns

Another way to visualize the rolling returns is to see which of the three was the best for what percentage of the 16 years from Apr 2005 to July 2021.

This chart makes an important point. Both the Low Volatility index and our version of the strategy underperform the NIFTY for stretches of time. On a 1-year trailing basis, both the Low Volatility index and our version of the Low Vol strategy underperform the NIFTY for 17% of the time. That’s 2.7 years out of 16.

On a longer time frame, this shrinks significantly underscoring the importance of sticking with it to reap the eventual outperformance.

The CM Low Vol portfolio outperforms both the NIFTY and the NIFTY100 Low Vol Index 81% of the time over any 3-year basis and 52% of the time on any 1-year basis.

Why does Low-Volatility work?

Slicing return performance every which way says buying a portfolio of low-volatility stocks with a few screening conditions helps outperform the index. But why might low-volatility stocks offer an edge?

Looking at frequent portfolio holdings in the past offers some insight:

  1. HDFC Bank
  2. Hindustan Unilever
  3. Hero Motocorp
  4. Infosys
  5. ACC
  6. Bajaj Auto
  7. Cipla
  8. Dabur
  9. Grasim
  10. ITC

Note these are stocks that were frequently part of the portfolio over the backtest period and not necessarily current constituents.

Interesting how the list of companies looks a lot like lists of Quality stocks. In fact, there is a significant overlap between the Low Volatility and Quality indices over time.

Two things seem to be common among the companies repeatedly picked by the low-volatility portfolio:

  • Tend to have a higher percentage of large caps at any time
  • Tend to hold businesses with reasonably stable earnings growth (consistent but not necessarily superior) with only negative surprises

A possible explanation could be behavioral. The typical active investor builds positions in anticipation of positive earnings surprises. Such an investor would not be interested in holding companies with little such scope.

It is logical then that in the first set of companies, some disappoint on the extent of earnings growth and therefore see significant price volatility as active investors exit them. This would automatically make the “no surprises” set of companies to be relatively less volatile.

Most low-volatility stocks tend to be highly liquid stocks with no shortage of supply or demand. Also, stocks like these have longer-term holders who don’t sell the stock based on short-term news flows which potentially acts as a dampener on rapid price moves both up and down.

Holding low volatility stocks seems to work well as a long-term investment strategy.

Get access to this Low Volatility portfolio along with investible insights & research, 5 other model portfolios, active strategies, and access to the slack community!

Capitalmind Low Vol


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